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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-Q
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|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2005
OR
| | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
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Commission file number 000-23777
PENSECO FINANCIAL SERVICES CORPORATION
Incorporated pursuant to the laws of Pennsylvania
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Internal Revenue Service -- Employer Identification No. 23-2939222
150 North Washington Avenue, Scranton, Pennsylvania 18503-1848
(570) 346-7741
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Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days. Yes |X| No | |
Indicate by checkmark whether the registrant is an accelerated filer (as defined
in Rule 12b-2 of the Act). | |
The total number of shares of the registrant's Common Stock, $0.01 par value,
outstanding on October 28, 2005 was 2,148,000.
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PENSECO FINANCIAL SERVICES CORPORATION
Page
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Part I -- FINANCIAL INFORMATION
Item 1. Financial Statements - Consolidated
Balance Sheets:
September 30, 2005.....................................3
December 31, 2004......................................3
Statements of Income:
Three Months Ended September 30, 2005..................4
Three Months Ended September 30, 2004..................4
Nine Months Ended September 30, 2005...................5
Nine Months Ended September 30, 2004...................5
Statements of Cash Flows:
Nine Months Ended September 30, 2005...................6
Nine Months Ended September 30, 2004...................6
Notes to Financial Statements.............................7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations......................................14
Item 3. Quantitative and Qualitative Disclosures About Market Risk.......25
Item 4. Controls and Procedures..........................................26
Part II -- OTHER INFORMATION
Item 1. Legal Proceedings................................................26
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds......26
Item 3. Defaults Upon Senior Securities..................................26
Item 4. Submission of Matters to a Vote of Security Holders..............26
Item 5. Other Information................................................26
Item 6. Exhibits.........................................................26
Signatures...............................................................27
Certifications...........................................................38
PART I. FINANCIAL INFORMATION, Item 1 -- Financial Statements
PENSECO FINANCIAL SERVICES CORPORATION
CONSOLIDATED BALANCE SHEETS
(unaudited)
(in thousands, except per share amounts)
September 30, December 31,
2005 2004
--------------- ---------------
ASSETS
Cash and due from banks $ 11,566 $ 7,763
Interest bearing balances with banks 10,156 534
Federal funds sold - -
--------------- ---------------
Cash and Cash Equivalents 21,722 8,297
Investment securities:
Available-for-sale, at fair value 142,822 167,410
Held-to-maturity (fair value of $86,371
and $97,791, respectively) 84,957 95,268
--------------- ---------------
Total Investment Securities 227,779 262,678
Loans, net of unearned income 306,645 280,176
Less: Allowance for loan losses 3,704 3,600
--------------- ---------------
Loans, Net 302,941 276,576
Bank premises and equipment 9,200 9,233
Other real estate owned 122 176
Accrued interest receivable 3,132 3,406
Other assets 3,245 3,342
--------------- ---------------
Total Assets $ 568,141 $ 563,708
=============== ===============
LIABILITIES
Deposits:
Non-interest bearing $ 91,488 $ 82,938
Interest bearing 305,459 312,363
--------------- ---------------
Total Deposits 396,947 395,301
Other borrowed funds:
Repurchase agreements 25,937 18,398
Short-term borrowings 926 886
Long-term borrowings 77,736 84,620
Accrued interest payable 1,098 886
Other liabilities 1,108 1,241
--------------- ---------------
Total Liabilities 503,752 501,332
--------------- ---------------
STOCKHOLDERS' EQUITY
Common stock ($ .01 par value, 15,000,000 shares
authorized, 2,148,000 shares issued and outstanding) 21 21
Surplus 10,819 10,819
Retained earnings 53,168 50,832
Accumulated other comprehensive income 381 704
--------------- ---------------
Total Stockholders' Equity 64,389 62,376
--------------- ---------------
Total Liabilities and Stockholders' Equity $ 568,141 $ 563,708
=============== ===============
PENSECO FINANCIAL SERVICES CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(unaudited)
(in thousands, except per share amounts)
Three Months Ended Three Months Ended
September 30, 2005 September 30, 2004
------------------ ------------------
INTEREST INCOME
Interest and fees on loans $ 4,781 $ 3,468
Interest and dividends on investments:
U.S. Treasury securities and U.S. Agency obligations 1,538 1,976
States & political subdivisions 641 947
Other securities 43 21
Interest on Federal funds sold 84 14
Interest on balances with banks 62 16
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Total Interest Income 7,149 6,442
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INTEREST EXPENSE
Interest on time deposits of $100,000 or more 215 164
Interest on other deposits 1,083 790
Interest on other borrowed funds 891 897
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Total Interest Expense 2,189 1,851
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Net Interest Income 4,960 4,591
Provision for loan losses - 114
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Net Interest Income After Provision for Loan Losses 4,960 4,477
------------------ ------------------
OTHER INCOME
Trust department income 399 372
Service charges on deposit accounts 239 271
Merchant transaction income 1,436 1,698
Other fee income 332 289
Other operating income 158 200
Realized (losses) gains on securities, net - -
------------------ ------------------
Total Other Income 2,564 2,830
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OTHER EXPENSES
Salaries and employee benefits 2,215 2,235
Expense of premises and fixed assets 584 556
Merchant transaction expenses 1,136 1,344
Other operating expenses 1,411 1,251
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Total Other Expenses 5,346 5,386
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Income before income taxes 2,178 1,921
Applicable income taxes 481 306
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Net Income 1,697 1,615
Other comprehensive income, net of taxes:
Unrealized securities (losses) gains (110) 1,915
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Comprehensive Income $ 1,587 $ 3,530
================== ==================
Earnings per Common Share
(Based on 2,148,000 shares outstanding) $ 0.79 $ 0.75
Cash Dividends Declared Per Common Share $ 0.33 $ 0.30
PENSECO FINANCIAL SERVICES CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(unaudited)
(in thousands, except per share amounts)
Nine Months Ended Nine Months Ended
September 30, 2005 September 30, 2004
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INTEREST INCOME
Interest and fees on loans $ 13,448 $ 9,816
Interest and dividends on investments:
U.S. Treasury securities and U.S. Agency obligations 4,870 6,188
States & political subdivisions 1,978 2,675
Other securities 129 72
Interest on Federal funds sold 170 57
Interest on balances with banks 156 53
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Total Interest Income 20,751 18,861
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INTEREST EXPENSE
Interest on time deposits of $100,000 or more 555 501
Interest on other deposits 2,986 2,453
Interest on other borrowed funds 2,665 2,737
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Total Interest Expense 6,206 5,691
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Net Interest Income 14,545 13,170
Provision for loan losses 122 135
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Net Interest Income After Provision for Loan Losses 14,423 13,035
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OTHER INCOME
Trust department income 1,114 1,014
Service charges on deposit accounts 700 810
Merchant transaction income 3,848 4,097
Other fee income 897 848
Other operating income 490 481
Realized (losses) gains on securities, net (13) -
------------------ ------------------
Total Other Income 7,036 7,250
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OTHER EXPENSES
Salaries and employee benefits 6,811 6,792
Expense of premises and fixed assets 1,852 1,837
Merchant transaction expenses 3,084 3,281
Other operating expenses 4,102 3,618
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Total Other Expenses 15,849 15,528
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Income before income taxes 5,610 4,757
Applicable income taxes 1,147 634
------------------ ------------------
Net Income 4,463 4,123
Other comprehensive income, net of taxes:
Unrealized securities (losses) gains (323) (997)
------------------ ------------------
Comprehensive Income $ 4,140 $ 3,126
================== ==================
Earnings per Common Share
(Based on 2,148,000 shares outstanding) $ 2.08 $ 1.92
Cash Dividends Declared Per Common Share $ 0.99 $ 0.90
PENSECO FINANCIAL SERVICES CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(in thousands)
Nine Months Ended Nine Months Ended
September 30, 2005 September 30, 2004
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OPERATING ACTIVITIES
Net Income $ 4,463 $ 4,123
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation 550 624
Provision for loan losses 122 114
Deferred income tax provision (benefit) 87 60
Amortization of securities, (net of accretion) 1,076 1,191
Net realized losses (gains) on securities 13 -
Loss (gain) on other real estate 16 -
Decrease (increase) in interest receivable 274 (139)
Decrease (increase) in other assets 97 (323)
Increase (decrease) in income taxes payable 74 183
Increase (decrease) in interest payable 212 (318)
(Decrease) increase in other liabilities (127) 573
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Net cash provided by operating activities 6,857 6,088
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INVESTING ACTIVITIES
Purchase of investment securities available-for-sale (22,486) (49,543)
Proceeds from sales and maturities of investment securities available-for-sale 31,072 23,015
Purchase of investment securities to be held-to-maturity - -
Proceeds from repayments of investment securities available-for-sale 14,808 14,108
Proceeds from repayments of investment securities held-to-maturity 9,926 14,434
Net loans (originated) repaid (26,788) (23,656)
Proceeds from other real estate 339 121
Investment in premises and equipment (517) (93)
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Net cash provided (used) by investing activities 6,354 (21,614)
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FINANCING ACTIVITIES
Net (decrease) increase in demand and savings deposits (3,719) 11,181
Net proceeds (payments) on time deposits 5,365 (12,728)
Increase (decrease) in federal funds purchased - -
Increase (decrease) in repurchase agreements 7,539 6,450
Net increase (decrease) in short-term borrowings 40 (212)
Repayments of long-term borrowings (6,884) (6,648)
Cash dividends paid (2,127) (1,933)
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Net cash provided (used) by financing activities 214 (3,890)
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Net increase (decrease) in cash and cash equivalents 13,425 (19,416)
Cash and cash equivalents at January 1 8,297 38,355
------------------ ------------------
Cash and cash equivalents at September 30 $ 21,722 $ 18,939
================== ==================
The Company paid interest and income taxes of $5,994 and $1,055 and $6,009 and
$432, for the nine month periods ended September 30, 2005 and 2004,
respectively.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Quarter Ended September 30, 2005
(unaudited)
These Notes to Financial Statements reflect events subsequent to December 31,
2004, the date of the most recent Report of Independent Registered Public
Accounting Firm, through the date of this Quarterly Report on Form 10-Q for the
quarter ended September 30, 2005. These Notes to Financial Statements should be
read in conjunction with Financial Information and Other Information required to
be furnished as part of this Report, in particular, (1) Management's Discussion
and Analysis of Financial Condition and Results of Operations for the three
months ended September 30, 2005 and September 30, 2004 and for the nine months
ended September 30, 2005 and September 30, 2004, with respect to the Company's
net interest income, capital requirements and liquidity, (2) Part II, Item 6,
Exhibits and (3) the Company's Annual Report - Form 10-K for the year ended
December 31, 2004, incorporated herein by reference.
FORWARD LOOKING INFORMATION
This Form 10-Q contains forward-looking informational statements, in addition to
the historical financial information required by the Securities and Exchange
Commission. There are certain risks and uncertainties associated with these
forward-looking statements which could cause actual results to differ materially
from those stated herein. Such differences are discussed in the section entitled
"Management Discussion and Analysis of Financial Condition and Results of
Operations". These forward-looking statements reflect management's analysis as
of this point in time. Readers should review the other documents the Company
periodically files with the Securities and Exchange Commission in order to keep
apprised of any material changes.
NOTE 1 -- Principles of Consolidation
Penseco Financial Services Corporation (Company) is a financial holding company,
incorporated under the laws of Pennsylvania. It is the parent company of Penn
Security Bank and Trust Company (Bank), a Pennsylvania state chartered bank.
Intercompany transactions have been eliminated in preparing the consolidated
financial statements.
The accounting policies of the Company conform with accounting principles
generally accepted in the United States of America and with general practices
within the banking industry.
NOTE 2 -- Basis of Presentation
The unaudited consolidated financial statements have been prepared in accordance
with generally accepted accounting principles for interim financial information.
In the opinion of management, all adjustments that are of a normal recurring
nature and are considered necessary for a fair presentation have been included.
They are not, however, necessarily indicative of the results of consolidated
operations for a full year.
All information is presented in thousands of dollars, except per share amounts.
For further information, refer to the consolidated financial statements and
accompanying notes included in the Company's Annual Report - Form 10-K for the
year ended December 31, 2004.
NOTE 3 -- Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Material estimates that are particularly susceptible to significant change
relate to the determination of the allowance for losses on loans and the
valuation of real estate acquired in connection with foreclosures or in
satisfaction of loans. In connection with the determination of the allowances
for losses on loans and foreclosed real estate, management obtains independent
appraisals for significant properties.
NOTE 4 -- Investment Securities
Investments in securities are classified in two categories and accounted for as
follows:
Securities Held-to-Maturity Bonds, notes, debentures and mortgage-backed
securities for which the Company has the positive intent and ability to hold to
maturity are reported at cost, adjusted for amortization of premiums and
accretion of discounts computed on the straight-line basis, which approximates
the interest method, over the remaining period to maturity.
Securities Available-for-Sale Bonds, notes, debentures, mortgage-backed
securities and certain equity securities not classified as securities to be held
to maturity are carried at fair value with unrealized holding gains and losses,
net of tax, reported as a net amount in a separate component of stockholders'
equity until realized.
The amortization of premiums on mortgage-backed securities is done based on
management's estimate of the lives of the securities, adjusted, when necessary,
for advanced prepayments in excess of those estimates.
Realized gains and losses on the sale of securities available-for-sale are
determined using the specific identification method and are reported as a
separate component of other income in the Statements of Income. Unrealized gains
and losses are included as a separate item in computing comprehensive income.
The amortized cost and fair value of investment securities at September 30, 2005
and December 31, 2004 are as follows:
Available-for-Sale
Gross Gross
Amortized Unrealized Unrealized Fair
September 30, 2005 Cost Gains Losses Value
- --------------------------------------------------------------------------------
U.S. Treasury securities $ - $ - $ - $ -
U.S. Agency securities 65,246 131 329 65,048
Mortgage-backed securities 48,796 - 334 48,462
States & political subdivisions 20,696 854 9 21,541
- --------------------------------------------------------------------------------
Total Debt Securities 134,738 985 672 135,051
Equity securities 7,507 364 100 7,771
- --------------------------------------------------------------------------------
Total Available-for-Sale $ 142,245 $ 1,349 $ 772 $ 142,822
- --------------------------------------------------------------------------------
Available-for-Sale
Gross Gross
Amortized Unrealized Unrealized Fair
December 31, 2004 Cost Gains Losses Value
- --------------------------------------------------------------------------------
U.S. Treasury securities $ 5,000 $ 77 $ - $ 5,077
U.S. Agency securities 70,777 510 541 70,746
Mortgage-backed securities 53,782 36 36 53,782
States & political subdivisions 30,910 686 56 31,540
- --------------------------------------------------------------------------------
Total Debt Securities 160,469 1,309 633 161,145
Equity securities 5,873 392 - 6,265
- --------------------------------------------------------------------------------
Total Available-for-Sale $ 166,342 $ 1,701 $ 633 $ 167,410
- --------------------------------------------------------------------------------
Held-to-Maturity
Gross Gross
Amortized Unrealized Unrealized Fair
September 30, 2005 Cost Gains Losses Value
- --------------------------------------------------------------------------------
Mortgage-backed securities $ 55,706 $ 7 $ 1,059 $ 54,654
States & political subdivisions 29,251 2,466 - 31,717
- --------------------------------------------------------------------------------
Total Held-to-Maturity $ 84,957 $ 2,473 $ 1,059 $ 86,371
- --------------------------------------------------------------------------------
Held-to-Maturity
Gross Gross
Amortized Unrealized Unrealized Fair
December 31, 2004 Cost Gains Losses Value
- --------------------------------------------------------------------------------
Mortgage-backed securities $ 66,019 $ 10 $ 357 $ 65,672
States & political subdivisions 29,249 2,870 - 32,119
- --------------------------------------------------------------------------------
Total Held-to-Maturity $ 95,268 $ 2,880 $ 357 $ 97,791
- --------------------------------------------------------------------------------
The amortized cost and fair value of debt securities at September 30, 2005 by
contractual maturity are shown below. Expected maturities will differ from
contractual maturities because borrowers may have the right to call or prepay
obligations with or without call or prepayment penalties.
September 30, 2005 Available-for-Sale Held-to-Maturity
- -----------------------------------------------------------------------------------------
Amortized Fair Amortized Fair
Cost Value Cost Value
- -----------------------------------------------------------------------------------------
Due in one year or less:
U.S. Treasury securities $ - $ - $ - $ -
U.S. Agency securities 55,255 54,926 - -
After one year through five years:
U.S. Agency securities 9,991 10,122 - -
After ten years:
States & political subdivisions 20,696 21,541 29,251 31,717
- -----------------------------------------------------------------------------------------
Subtotal 85,942 86,589 29,251 31,717
Mortgage-backed securities 48,796 48,462 55,706 54,654
- -----------------------------------------------------------------------------------------
Total Debt Securities $ 134,738 $ 135,051 $ 84,957 $ 86,371
- -----------------------------------------------------------------------------------------
The gross fair value and unrealized losses of the Company's investments,
aggregated by investment category and length of time that individual securities
have been in a continuous unrealized loss position, at September 30, 2005 and
December 31, 2004 are as follows:
Less than twelve months Twelve months or more Totals
-------------------------- -------------------------- --------------------------
Fair Unrealized Fair Unrealized Fair Unrealized
September 30, 2005 Value Losses Value Losses Value Losses
- ------------------------------------------------------ -------------------------- --------------------------
U.S. Agency securities $ 15,042 $ 38 $ 39,884 $ 291 $ 54,926 $ 329
Mortgage-backed securities 27,196 160 75,492 1,233 102,688 1,393
States & political
subdivisions 691 9 - - 691 9
Equities 1,826 100 - - 1,826 100
-------------------------- -------------------------- --------------------------
Total $ 44,755 $ 307 $115,376 $ 1,524 $ 160,131 $ 1,831
========================== ========================== ==========================
Less than twelve months Twelve months or more Totals
-------------------------- -------------------------- --------------------------
Fair Unrealized Fair Unrealized Fair Unrealized
December 31, 2004 Value Losses Value Losses Value Losses
- ------------------------------------------------------ -------------------------- --------------------------
U.S. Agency securities $ 35,064 $ 541 $ - $ - $ 35,064 $ 541
Mortgage-backed securities 93,527 393 - - 93,527 393
States & political
subdivisions 3,257 24 4,889 32 8,146 56
-------------------------- -------------------------- --------------------------
Total $ 131,848 $ 958 $ 4,889 $ 32 $ 136,737 $ 990
========================== ========================== ==========================
The above table at September 30, 2005, includes thirty-six (36) securities that
have unrealized losses for less than twelve months and six (6) securities that
has been in an unrealized loss position for twelve or more months.
During the third quarter of 2005, Hurricanes Katrina and Rita ravaged the Gulf
Coast region. Moody's investors service had placed fifty-one (51) debt issuers
in Louisiana and Mississippi on its watch list. The Company does not hold any of
these securities.
U.S. Agency Securities
The unrealized losses on the Company's investments in these obligations were
caused by recent interest rate increases. The contractual terms of these
investments do not permit the issuer to settle the securities at a price less
than the par value of the investment. Because the Company has the ability to
hold these investments until a recovery of fair value, which may be maturity,
the Company does not consider these investments to be other-than-temporarily
impaired at September 30, 2005.
Mortgage-Backed Securities
The unrealized losses on the Company's investment in mortgage-backed securities
were caused by recent interest rate increases. The contractual cash flows of
these investments are guaranteed by an agency of the U.S. government.
Accordingly, it is expected that these securities would not be settled at a
price less than the amortized cost of the Company's investment. Because the
decline in market value is attributable to changes in interest rates and not
credit quality and because the Company has the ability to hold these investments
until a recovery of fair value, which may be maturity, the Company does not
consider these investments to be other-than-temporarily impaired at September
30, 2005.
States & Political Subdivisions
The unrealized losses on the Company's investments in these obligations were
caused by recent interest rate increases. The contractual terms of these
investments do not permit the issuer to settle the securities at a price less
than the par value of the investment. Because the Company has the ability to
hold these investments until a recovery of fair value, which may be maturity,
the Company does not consider these investments to be other-than-temporarily
impaired at September 30, 2005.
Marketable Equity Securities
The unrealized losses on the Company's investment in marketable equity
securities were caused primarily by recent interest rate increases and other
market conditions. The Company's investments in marketable equity securities
consist primarily of investments in common stock of companies in the financial
services industry. Because the Company has the ability and intent to hold these
investments for a reasonable period of time sufficient for a forecasted recovery
of fair value, the Company does not consider these investments to be
other-than-temporarily impaired at September 30, 2005.
NOTE 5 -- Loan Portfolio
Details regarding the Company's loan portfolio:
September 30, December 31,
As Of: 2005 2004
- --------------------------------------------------------------------------------
Real estate - construction and land development $ 12,848 $ 6,805
Real estate mortgages 213,363 196,149
Commercial 42,819 41,560
Credit card and related plans 3,054 2,872
Installment 26,507 25,679
Obligations of states & political subdivisions 8,054 7,111
- --------------------------------------------------------------------------------
Loans, net of unearned income 306,645 280,176
Less: Allowance for loan losses 3,704 3,600
- --------------------------------------------------------------------------------
Loans, net $ 302,941 $ 276,576
- --------------------------------------------------------------------------------
NOTE 6 -- Loan Servicing
The Company generally retains the right to service mortgage loans sold to
others. The cost allocated to the mortgage servicing rights retained has been
recognized as a separate asset and is being amortized in proportion to and over
the period of estimated net servicing income.
Mortgage servicing rights are evaluated for impairment based on the fair value
of those rights. Fair values are estimated using discounted cash flows based on
current market rates of interest and current expected future prepayment rates.
For purposes of measuring impairment, the rights must be stratified by one or
more predominant risk characteristics of the underlying loans. The Company
stratifies its capitalized mortgage servicing rights based on the product type,
interest rate and term of the underlying loans. The amount of impairment
recognized is the amount, if any, by which the amortized cost of the rights for
each stratum exceed the fair value.
NOTE 7 -- Long-Term Debt
During 2003, the Bank borrowed $100,000 from the Federal Home Loan Bank, in four
loans with various maturity dates, to finance the purchase of a mortgaged-backed
security.
The loans are secured by a general collateral pledge of the Company.
A summary of the long-term debt at September 30, 2005 is as follows:
Note payable, due in monthly installments of $161, including
principal and interest at a fixed rate of 2.73%, maturing March, 2008. $ 4,653
Note payable, due in monthly installments of $253, including
principal and interest at a fixed rate of 3.22%, maturing March, 2010. 12,700
Note payable, due in monthly installments of $430, including
principal and interest at a fixed rate of 3.74%, maturing March, 2013. 33,705
Note payable, due in monthly installments of $186, including
principal and interest at a fixed rate of 4.69%, maturing March, 2023. 26,678
--------
Total long-term debt $ 77,736
========
The Company has agreed to maintain sufficient qualifying collateral to fully
secure the above borrowings.
Aggregate maturities of long-term debt at September 30, 2005 are as follows:
September 30, Principal
------------- ---------
2006 $ 9,464
2007 9,801
2008 9,181
2009 8,533
2010 7,326
Thereafter 33,431
---------
$ 77,736
=========
NOTE 8 -- Employee Benefit Plans
The components of the net periodic benefit costs are as follows:
Pension Benefits Other Benefits
------------------ -----------------
Nine months ended September 30, 2005 2004 2005 2004
- -----------------------------------------------------------------------------
Service cost $ 308 $ 297 $ 1 $ 1
Interest cost 502 493 3 4
Expected return on plan assets (566) (525) - -
Amortization of prior service cost 1 - 2 2
Amortization of net (gain) loss 81 93 - -
- -----------------------------------------------------------------------------
Net periodic pension cost $ 326 $ 358 $ 6 $ 7
- -----------------------------------------------------------------------------
Contributions
- -------------
The Company previously disclosed in its financial statements for the year ended
December 31, 2004, that it expected to contribute $375 to its pension plan and
$13 to its postretirement plan in 2005. As of October 15, 2005, $282 has been
contributed to the pension plan. The pension and postretirement contribution
estimates have not changed since December 31, 2004.
NOTE 9 -- Regulatory Matters
The Company and the Bank are subject to various regulatory capital requirements
administered by the Federal banking agencies. Failure to meet minimum capital
requirements can initiate certain mandatory--and possibly additional
discretionary--actions by regulators that, if undertaken, could have a direct
material effect on the Company and the Bank's Consolidated Financial Statements.
Under capital adequacy guidelines and the regulatory framework for prompt
corrective action, the Company and the Bank must meet specific capital
guidelines that involve quantitative measures of their assets, liabilities, and
certain off-balance sheet items as calculated under regulatory accounting
practices. The Company and the Bank's capital amounts and classifications are
also subject to qualitative judgements by the regulators about components, risk
weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Company and the Bank to maintain minimum amounts and ratios (set
forth in the Capital Adequacy table below) of Tier I and Total Capital to
risk-weighted assets and of Tier I Capital to average assets (Leverage ratio).
The table also presents the Company's actual capital amounts and ratios. The
Bank's actual capital amounts and ratios are substantially identical to the
Company's. Management believes, as of September 30, 2005, that the Company and
the Bank meet all capital adequacy requirements to which they are subject.
As of September 30, 2005, the most recent notification from the Federal Deposit
Insurance Corporation (FDIC) categorized the Company as "well capitalized" under
the regulatory framework for prompt corrective action. To be categorized as
"well capitalized", the Company must maintain minimum Tier I Capital, Total
Capital and Leverage ratios as set forth in the Capital Adequacy table. There
are no conditions or events since that notification that management believes
have changed the Company's categorization by the FDIC.
The Company and Bank are also subject to minimum capital levels, which could
limit the payment of dividends, although the Company and Bank currently have
capital levels, which are in excess of minimum capital level ratios required.
The Pennsylvania Banking Code restricts capital funds available for payment of
dividends to the Retained Earnings of the Bank. Accordingly, at September 30,
2005, the balances in the Capital Stock and Surplus accounts totalling $10,840
are unavailable for dividends.
In addition, the Bank is subject to restrictions imposed by Federal law on
certain transactions with the Company's affiliates. These transactions include
extensions of credit, purchases of or investments in stock issued by the
affiliate, purchases of assets subject to certain exceptions, acceptance of
securities issued by an affiliate as collateral for
loans, and the issuance of guarantees, acceptances, and letters of credit on
behalf of affiliates. These restrictions prevent the Company's affiliates from
borrowing from the Bank unless the loans are secured by obligations of
designated amounts. Further, the aggregate of such transactions by the Bank with
a single affiliate is limited in amount to 10 percent of the Bank's Capital
Stock and Surplus, and the aggregate of such transactions with all affiliates is
limited to 20 percent of the Bank's Capital Stock and Surplus. The Federal
Reserve System has interpreted "Capital Stock and Surplus" to include undivided
profits.
Actual Regulatory Requirements
- ---------------------------------------------- --------------------------------------------
For Capital To Be
Adequacy Purposes "Well Capitalized"
As of September 30, 2005 Amount Ratio Amount Ratio Amount Ratio
- ----------------------------------------------------------------------------------------------
Total Capital
(to Risk Weighted Assets) $ 67,366 18.80% > $ 28,674 > 8.0% > $ 35,842 > 10.0%
- - - -
Tier 1 Capital
(to Risk Weighted Assets) $ 63,662 17.76% > $ 14,337 > 4.0% > $ 21,505 > 6.0%
- - - -
Tier 1 Capital
(to Average Assets) $ 63,662 11.21% > $ * > * > $ 28,399 > 5.0%
- - - -
*3.0% ($17,039), 4.0% ($22,719) or 5.0% ($28,399) depending on the bank's CAMELS
Rating and other regulatory risk factors.
Actual Regulatory Requirements
- ---------------------------------------------- --------------------------------------------
For Capital To Be
Adequacy Purposes "Well Capitalized"
As of December 31, 2004 Amount Ratio Amount Ratio Amount Ratio
- ----------------------------------------------------------------------------------------------
Total Capital
(to Risk Weighted Assets) $ 64,822 20.03% > $ 25,890 > 8.0% > $ 32,362 > 10.0%
- - - -
Tier I Capital
(to Risk Weighted Assets) $ 61,222 18.92% > $ 12,945 > 4.0% > $ 19,417 > 6.0%
- - - -
Tier I Capital
(to Average Assets) $ 61,222 10.53% > $ * > * > $ 29,068 > 5.0%
- - - -
*3.0% ($17,441), 4.0% ($23,254) or 5.0% ($29,068) depending on the bank's CAMELS
Rating and other regulatory risk factors.
PART 1. FINANCIAL INFORMATION, Item 2 --
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The following commentary provides an overview of the financial condition and
significant changes in the results of operations of Penseco Financial Services
Corporation and its subsidiary, Penn Security Bank and Trust Company, for the
three months ended September 30, 2005 and September 30, 2004 and for the nine
months ended September 30, 2005 and September 30, 2004. Throughout this review,
the subsidiary of Penseco Financial Services Corporation, Penn Security Bank and
Trust Company, is referred to as the "Company". All intercompany accounts and
transactions have been eliminated in preparing the consolidated financial
statements. All information is presented in thousands of dollars, except as
indicated.
Critical Accounting Policies
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Provision (allowance) for possible loan losses - The provision for loan losses
is based on past loan loss experience, management's evaluation of the potential
loss in the current loan portfolio under current economic conditions and such
other factors as, in management's best judgement, deserve current recognition in
estimating loan losses. The annual provision for loan losses charged to
operating expense is that amount which is sufficient to bring the balance of the
allowance for possible loan losses to an adequate level to absorb anticipated
losses.
Actuarial assumptions associated with pension, post-retirement and other
employee benefit plans - These assumptions include discount rate, rate of future
compensation increases and expected return on plan assets.
Provision for income taxes - Management believes that the assumptions and
judgements used to record tax related assets or liabilities have been
appropriate.
Fair value of certain investment securities - Fair value of investment
securities are based on quoted market prices.
Loan servicing rights - Mortgage servicing rights are evaluated for impairment
based on the fair value of those rights. Fair values are estimated using
discounted cash flows based on current market rates of interest and current
expected future prepayment rates. For purposes of measuring impairment, the
rights must be stratified by one or more predominant risk characteristics of the
underlying loans. The Company stratifies its capitalized mortgage servicing
rights based on the product type, interest rate and term of the underlying
loans. The amount of impairment recognized is the amount, if any, by which the
amortized cost of the rights for each stratum exceed the fair value.
Premium amortization - The amortization of premiums on mortgage-backed
securities is done based on management's estimate of the lives of the
securities, adjusted, when necessary, for advanced prepayments in excess of
those estimates.
Executive Summary
Penseco Financial Services Corporation reported an increase in net income for
the three months ended September 30, 2005 increased $82 or 5.1% to $1,697 or
$.79 per share compared with $1,615 or $.75 per share from the year ago period.
Net interest income after provision for loan losses increased $483 or 10.8%, to
$4,960 for three months ended September 30, 2005 compared to $4,477 for the same
quarter of 2004. Partly, the increase resulted from higher interest on loans due
to net loan growth of $12.1 million sequentially from June 30, 2005 and $42.5
million from the year ago period as well as interest rates increases.
For the nine months ended September 30, 2005, net income increased $340 or 8.2%
to $4,463 or $2.08 per share compared to the year ago period of $4,123 or $1.92
per share. Net interest income after provision for loan losses increased $1,388
or 10.6% to $14,423 for the nine months ended September 30, 2005 from $13,035
for the same period of 2004. The increase in net interest income continues in
part from net loan growth of $26.3 million from December 31, 2004 and a $42.5
million increase on a year over year comparison, along with increases in
interest rates.
Net Interest Income and Net Interest Margin
Net interest income, the largest contributor to the Company's earnings, is
defined as the difference between interest income on assets and the cost of
funds supporting those assets. Average earning assets are composed primarily of
loans and investments while deposits, short-term and long-term borrowings
represent interest-bearing liabilities. Variations in the volume and mix of
these assets and liabilities, as well as changes in the yields earned and rates
paid, are determinants of changes in net interest income.
Net interest income after provision for loan losses increased $483 or 10.8% to
$4,960 for the three months ended September 30, 2005 compared to $4,477 for the
three months ended September 30, 2004. The average yield on earning assets
increased 61 basis points, largely due to the increase in interest rates. Also,
there was an increase of $41.9 million in average loans from the comparable
period of 2004.
The net interest margin represents the Company's net yield on its average
earning assets and is calculated as net interest income divided by average
earning assets. In the three months ended September 30, 2005, net interest
margin was 3.62% increasing 34 basis points from 3.28% in the same period of
2004.
Total average earning assets and average interest bearing funds decreased in the
three months ended September 30, 2005 as compared to 2004. Average earning
assets decreased $11.8 million or 2.1%, from $560.4 million in 2004 to $548.6
million in 2005 and average interest bearing funds decreased $20.4 million, or
4.7%, from $436.5 million to $416.1 million for the same period, mainly due to
lower money market and time-deposit savings, as well as reductions in long-term
borrowings. As a percentage of average assets, earning assets increased to 96.4%
for the three months ended September 30, 2005 from 96.3% for the year ago
period.
Changes in the mix of both earning assets and funding sources also impacted net
interest income in the three months ended September 30, 2005 and 2004. Average
loans as a percentage of average earning assets increased from 46.0% in 2004 to
54.6% in 2005, due in part to the increase of new mortgages as well as
commercial loans; average investments decreased $61.3 million from 52.3% to
42.3%. Average short-term investments, federal funds sold and interest bearing
balances with banks increased $7.6 million to $16.9 from $9.3 and also increased
as a percentage of average earning assets from 1.7% in 2004 to 3.1% in 2005.
Average time deposits decreased $5.5 million or 4.6%. Average long-term
borrowings decreased $9.2 while repurchase agreements increased $4.5.
Shifts in the interest rate environment and competitive factors affected the
rates paid for funds as well as the yields earned on assets. The investment
securities tax equivalent yield decreased 28 basis points from 4.68% in the
three months ended September 30, 2004 to 4.40% for 2005. However, average loan
yields increased 100 basis points, from 5.38% in the three months ended
September 30, 2004 to 6.38% in 2005.
The average time deposit costs increased 76 basis points from 2.28% in 2004 to
3.04% in 2005, along with money market accounts increasing 76 basis points from
..78% in 2004 to 1.54% in 2005. Also, repurchase agreements increased 89 basis
points from .74% in 2004 to 1.63% in 2005.
The most significant change in net interest income has been the growth in our
average loan portfolio of $41.9 million mostly in commercial and real estate
loans which will have a significant positive impact on our net interest margin.
Distribution of Assets, Liabilities and Stockholders' Equity / Interest Rates
and Interest Differential
The table below presents average balances, interest income on a fully taxable
equivalent basis and interest expense, as well as average rates earned and paid
on the Company's major asset and liability items for the three months ended
September 30, 2005 and September 30, 2004.
- ----------------------------------------------------------------------------------------------------------
September 30, 2005 September 30, 2004
ASSETS Average Revenue/ Yield/ Average Revenue/ Yield/
Balance Expense Rate Balance Expense Rate
- ----------------------------------------------------------------------------------------------------------
Investment Securities
Available-for-sale:
U.S. Treasury securities $ - $ - - $ 5,200 $ 86 6.62%
U.S. Agency obligations 115,931 898 3.10% 134,351 1,094 3.26%
States & political
subdivisions 21,521 232 6.53% 47,062 538 6.93%
Federal Home Loan Bank stock 4,806 28 2.33% 5,894 19 1.29%
Other 2,768 15 2.17% 567 2 1.41%
Held-to-maturity:
U.S. Agency obligations 57,581 640 4.45% 70,867 796 4.49%
States & political
subdivisions 29,251 409 8.47% 29,248 409 8.47%
Loans, net of unearned income:
Real estate mortgages 219,421 3,442 6.27% 187,013 2,571 5.50%
Commercial 43,074 749 6.96% 37,090 465 5.01%
Consumer and other 37,300 590 6.33% 33,826 432 5.11%
Federal funds sold 9,833 84 3.42% 3,519 14 1.59%
Interest on balances with banks 7,096 62 3.49% 5,787 16 1.11%
- ----------------------------------------------------------------------------------------------------------
Total Earning Assets/Total Interest
Income $ 548,582 7,149 5.21% 560,424 $ 6,442 4.60%
- ----------------------------------------------------------------------------------------------------------
Cash and due from banks 9,486 8,816
Bank premises and equipment 9,184 9,502
Accrued interest receivable 2,973 3,391
Other assets 2,546 3,309
Less: Allowance for loan losses 3,714 3,498
- ----------------------------------------------------------------------------------------------------------
Total Assets $ 569,057 $ 581,944
- ----------------------------------------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits:
Demand-Interest bearing $ 34,040 $ 50 0.59% $ 32,484 $ 26 0.32%
Savings 79,418 70 0.35% 82,997 73 0.35%
Money markets 81,359 313 1.54% 89,365 174 0.78%
Time - Over $100 26,456 215 3.25% 27,886 164 2.35%
Time - Other 87,415 650 2.97% 91,478 517 2.26%
Federal funds purchased - - - - - -
Repurchase agreements 28,414 116 1.63% 23,876 44 0.74%
Short-term borrowings 226 2 3.54% 525 2 1.52%
Long-term borrowings 78,747 773 3.93% 87,851 851 3.87%
- ----------------------------------------------------------------------------------------------------------
Total Interest Bearing Liabilities/
Total Interest Expense 416,075 $ 2,189 2.10% 436,462 $ 1,851 1.70%
- ----------------------------------------------------------------------------------------------------------
Demand - Non-interest bearing 87,556 85,225
All other liabilities 1,309 349
Stockholders' equity 64,117 59,908
- ----------------------------------------------------------------------------------------------------------
Total Liabilities and
Stockholders' Equity $ 569,057 $ 581,944
- ----------------------------------------------------------------------------------------------------------
Interest Spread 3.11% 2.90%
- ----------------------------------------------------------------------------------------------------------
Net Interest Income $ 4,960 $ 4,591
- ----------------------------------------------------------------------------------------------------------
FINANCIAL RATIOS
Net interest margin 3.62% 3.28%
Return on average assets 1.19% 1.11%
Return on average equity 10.59% 10.78%
Average equity to average assets 11.27% 10.29%
Dividend payout ratio 41.77% 38.87%
- ----------------------------------------------------------------------------------------------------------
Net interest income after provision for loan losses increased $1,388 or 10.6% to
$14,423 for the first nine months of 2005 compared to $13,035 for the first nine
months of 2004. The average yield on earning assets increased 58 basis points,
largely due to the increase in interest rates. Also, there was an increase of
$42.5 million in average loans from the comparable period of 2004.
The net interest margin represents the Company's net yield on its average
earning assets and is calculated as net interest income divided by average
earning assets. In the first nine months of 2005, net interest margin was 3.54%
increasing 42 basis points from 3.12% in the same period of 2004.
Total average earning assets and average interest bearing funds decreased in the
first nine months of 2005 as compared to 2004. Average earning assets decreased
$14.5 million or 2.6%, from $562.6 million in 2004 to $548.1 million in 2005 and
average interest bearing funds decreased $20.6 million, or 4.7%, from $438.5
million to $417.9 million for the same period, mainly due to lower money market,
time deposits and long-term borrowings. As a percentage of average assets,
earning assets increased to 96.5% for the first nine months of 2005 from 96.4%
for the year ago period.
Changes in the mix of both earning assets and funding sources also impacted net
interest income in the first nine months of 2005 and 2004. Average loans as a
percentage of average earning assets increased from 44.6% in 2004 to 53.5% in
2005, due in part to the increase of new mortgages as well as commercial loans.
Average investments decreased $57.4 million from 52.8% to 43.7%. Average
short-term investments, federal funds sold and interest bearing balances with
banks increased $.5 million to $15.5 from $15.0 and also increased as a
percentage of average earning assets from 2.7% in 2004 to 2.8% in 2005. Average
time deposits decreased $11.6 million or 9.9% from 28.2% of interest bearing
liabilities in 2004 to 26.8% in 2005. Average long-term borrowings decreased
$9.0 while repurchase agreements increased $4.1.
Shifts in the interest rate environment and competitive factors affected the
rates paid for funds as well as the yields earned on assets. The investment
securities tax equivalent yield decreased 18 basis points from 4.63% for the
first nine months of 2004 to 4.45% for 2005. However, average loan yields
increased 90 basis points, from 5.22% for the first nine months of 2004 to 6.12%
in 2005.
The average time deposit costs increased 52 basis points from 2.28% in 2004 to
2.80% in 2005, along with money market accounts increasing 60 basis points from
..73% in 2004 to 1.33% in 2005. Also, repurchase agreements increased 70 basis
points from .73% in 2004 to 1.43% in 2005.
The most significant change in net interest income has been the growth in our
loan portfolio of $42.5 million mostly in commercial and real estate loans which
will have a significant positive impact on the net interest margin.
Distribution of Assets, Liabilities and Stockholders' Equity / Interest Rates
and Interest Differential
The table below presents average balances, interest income on a fully taxable
equivalent basis and interest expense, as well as average rates earned and paid
on the Company's major asset and liability items for the nine months ended
September 30, 2005 and September 30, 2004.
- ----------------------------------------------------------------------------------------------------------
September 30, 2005 September 30, 2004
ASSETS Average Revenue/ Yield/ Average Revenue/ Yield/
Balance Expense Rate Balance Expense Rate
- ----------------------------------------------------------------------------------------------------------
Investment Securities
Available-for-sale:
U.S. Treasury securities $ 2,466 $ 127 6.87% $ 6,575 $ 285 5.78%
U.S. Agency obligations 115,830 2,708 3.12% 135,161 3,322 3.28%
States & political
subdivisions 24,649 767 6.29% 43,127 1,470 6.89%
Federal Home Loan Bank stock 4,980 107 2.86% 5,714 62 1.45%
Other 1,354 22 2.17% 537 10 2.48%
Held-to-maturity:
U.S. Agency obligations 60,921 2,035 4.45% 76,519 2,581 4.50%
States & political
subdivisions 29,250 1,211 8.36% 29,294 1,205 8.31%
Loans, net of unearned income:
Real estate mortgages 212,927 9,661 6.05% 181,477 7,228 5.31%
Commercial 43,343 2,037 6.27% 35,041 1,274 4.85%
Consumer and other 36,891 1,750 6.33% 34,214 1,314 5.12%
Federal funds sold 7,735 170 2.93% 7,161 57 1.06%
Interest on balances with banks 7,719 156 2.70% 7,790 53 0.91%
- ----------------------------------------------------------------------------------------------------------
Total Earning Assets/Total Interest
Income 548,065 $ 20,751 5.05% 562,610 $ 18,861 4.47%
- ----------------------------------------------------------------------------------------------------------
Cash and due from banks 8,741 8,576
Bank premises and equipment 9,138 9,683
Accrued interest receivable 2,921 3,172
Other assets 2,797 3,165
Less: Allowance for loan losses 3,681 3,498
- ----------------------------------------------------------------------------------------------------------
Total Assets $ 567,981 $ 583,708
- ----------------------------------------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits:
Demand-Interest bearing $ 32,975 $ 129 0.52% $ 31,312 $ 76 0.32%
Savings 80,059 207 0.34% 81,928 274 0.45%
Money markets 85,419 852 1.33% 89,071 490 0.73%
Time - Over $100 25,147 555 2.94% 28,936 501 2.31%
Time - Other 86,716 1,798 2.76% 94,605 1,613 2.27%
Federal funds purchased - - - - - -
Repurchase agreements 26,218 281 1.43% 22,144 121 0.73%
Short-term borrowings 312 9 3.85% 476 4 1.12%
Long-term borrowings 81,064 2,375 3.91% 90,072 2,612 3.87%
- ----------------------------------------------------------------------------------------------------------
Total Interest Bearing Liabilities/
Total Interest Expense 417,910 $ 6,206 1.98% 438,544 $ 5,691 1.73%
- ----------------------------------------------------------------------------------------------------------
Demand - Non-interest bearing 85,678 82,517
All other liabilities 1,209 1,580
Stockholders' equity 63,184 61,067
- ----------------------------------------------------------------------------------------------------------
Total Liabilities and
Stockholders' Equity $ 567,981 $ 583,708
- ----------------------------------------------------------------------------------------------------------
Interest Spread 3.07% 2.74%
- ----------------------------------------------------------------------------------------------------------
Net Interest Income $ 14,545 $ 13,170
- -----------------------------------------------------------------------------------------------------------
FINANCIAL RATIOS
Net interest margin 3.54% 3.12%
Return on average assets 1.05% 0.94%
Return on average equity 9.42% 9.00%
Average equity to average assets 11.12% 10.46%
Dividend payout ratio 47.65% 46.88%
- -----------------------------------------------------------------------------------------------------------
Investments
The Company's investment portfolio consists primarily of two functions: To
provide liquidity and to contribute to earnings. To provide liquidity the
Company may invest in short-term securities such as Federal funds sold, interest
bearing deposits with banks, U.S. Treasury securities and U.S. Agency securities
all with maturities of one year or less. These funds are invested short-term to
ensure the availability of funds to meet customer demand for credit needs. The
Company enhances interest income by securing long-term investments within its
investment portfolio, by means of U.S. Treasury securities, U.S. Agency
securities, municipal securities and mortgage-backed securities generally with
maturities greater than one year.
Investments in securities are classified in two categories and accounted for as
follows:
Securities Held-to-Maturity Bonds, notes, debentures and mortgage-backed
securities for which the Company has the positive intent and ability to hold to
maturity are reported at cost, adjusted for amortization of premiums and
accretion of discounts computed on the straight-line basis, which approximates
the interest method, over the remaining period to maturity.
Securities Available-for-Sale Bonds, notes, debentures, mortgage-backed
securities and certain equity securities not classified as securities to be held
to maturity are carried at fair value with unrealized holding gains and losses,
net of tax, reported as a net amount in a separate component of stockholders'
equity until realized.
The amortization of premiums on mortgage-backed securities is determined based
on management's estimate of the lives of the securities, adjusted, when
necessary, for advanced prepayments in excess of those estimates.
Gains and losses on the sale of securities available-for-sale are determined
using the specific identification method and are reported as a separate
component of other income in the Statements of Income.
Deposits
The Company is largely dependent on its core deposit base to fund operations.
Management has competitively priced its deposit products in checking, savings,
money market and time deposits to provide a stable source of funding.
As the economy shows strength and improves, migration of some deposits may
return to the equity markets as consumers become more prone to increased yields.
Historically, such changes in the Company's deposit base have been minimal.
Provision for Loan Losses
The provision for loan losses represents management's determination of the
amount necessary to bring the allowance for loan losses to a level that
management considers adequate to reflect the risk of future losses inherent in
the Company's loan portfolio. The process of determining the adequacy of the
allowance is necessarily judgmental and subject to changes in external
conditions. The allowance for loan losses reflects management's judgment as to
the level considered appropriate to absorb such losses based upon a review of
many factors, including historical loss experience, adverse situations that may
affect the borrower's ability to repay (including the timing of future
payments), economic conditions and trends, loan portfolio volume and mix, loan
performance trends, the value and adequacy of collateral, and the Company's
internal credit review process. Accordingly, there can be no assurance that
existing levels of the allowance will ultimately prove adequate to cover actual
loan losses. The quarterly provision for loan losses charged to operating
expense is that amount which is sufficient to bring the balance of the allowance
for possible loan losses to an adequate level to absorb anticipated losses.
Based on this ongoing evaluation, management determines the provision necessary
to maintain an appropriate allowance.
For the three months ended September 30, 2005, the provision for loan losses
decreased to $0 from $114 in the three months ended September 30, 2004. Loans
charged off totaled $18 and recoveries were $18 for the three months ended
September 30, 2005. In the same period of 2004, loans charged off were $15 and
recoveries were $1. In the first nine months of 2005, the provision for loan
losses was $122, a decrease from $135 in the first nine months of 2004. Loans
charged-off totaled $68 and recoveries of $50 for the nine months ended
September 30, 2005. In the same period of 2004 loans charged off were $43,
offset by recoveries of $8. At September 30, 2005 the allowance for loan losses
was set at $3,704 or 1.21% of loans based upon the bank's analysis.
Other Income
The following table sets forth information by category of other income for the
Company for three months ended September 30, 2005 and September 30, 2004,
respectively:
September 30, September 30,
Three Months Ended: 2005 2004
- ----------------------------------------------------------------------------
Trust department income $ 399 $ 372
Service charges on deposit accounts 239 271
Merchant transaction income 1,436 1,698
Other fee income 332 289
Other operating income 158 200
Realized (losses) gains on securities, net - -
- ----------------------------------------------------------------------------
Total Other Income $ 2,564 $ 2,830
- ----------------------------------------------------------------------------
Other income decreased $266 or 9.4% to $2,564 for the three months ended
September 30, 2005 compared with $2,830 for the similar period of 2004. Trust
income increased $27 or 7.3% from new business and market value increases.
Service charges on deposit accounts decreased $32 or 11.8%. Merchant transaction
income decreased $262 or 15.4% due to lower transaction volume. Other operating
income decreased $42 or 21.0% due to lower brokerage income of $85. Offsetting
this decrease were gains on the sale of foreclosed properties of $37.
The following table sets forth information by category of other income for the
Company for nine months ended September 30, 2005 and September 30, 2004,
respectively:
September 30, September 30,
Nine Months Ended: 2005 2004
- ----------------------------------------------------------------------------
Trust department income $ 1,114 $ 1,014
Service charges on deposit accounts 700 810
Merchant transaction income 3,848 4,097
Other fee income 897 848
Other operating income 490 481
Realized (losses) gains on securities, net (13) -
- ----------------------------------------------------------------------------
Total Other Income $ 7,036 $ 7,250
- ----------------------------------------------------------------------------
Other income decreased $214 or 3.0% to $7,036 during the first nine months ended
September 30, 2005 from $7,250 for the same period of 2004. Trust income
increased $100 or 9.8% from new business and market value increases. Service
charges on deposit accounts decreased $110 or 13.6%. Merchant transaction income
decreased $249 or 6.1% due to lower transaction volume. Other operating income
increased $9 or 1.9% from increased collection efforts on a previously written
off cash item and gains on the sale of foreclosed properties, offset by a
decrease in brokerage income of $107.
Other Expenses
The following table sets forth information by category of other expenses for the
Company for the three months ended September 30, 2005 and September 30, 2004,
respectively:
September 30, September 30,
Three Months Ended: 2005 2004
- ----------------------------------------------------------------------------
Salaries and employee benefits $ 2,215 $ 2,235
Expense of premises and fixed assets 584 556
Merchant transaction expenses 1,136 1,344
Other operating expenses 1,411 1,251
- ----------------------------------------------------------------------------
Total Other Expenses $ 5,346 $ 5,386
- ----------------------------------------------------------------------------
Total other expenses decreased $40 or .7% to $5,346 for the first three months
ended September 30, 2005 compared with $5,386 for the same period of 2004.
Merchant transaction expense decreased by $208 or 15.5% due to lower transaction
volume. Other operating expenses increased $160 or 12.8%, from increased
professional fees for ongoing banking business, costs related to the
Sarbanes-Oxley Act, an executive search and general operating expenses.
Applicable income taxes increased $175 due to higher income along with lower
tax-free income.
The following table sets forth information by category of other expenses for the
Company for the nine months ended September 30, 2005 and September 30, 2004,
respectively:
September 30, September 30,
Nine Months Ended: 2005 2004
- ----------------------------------------------------------------------------
Salaries and employee benefits $ 6,811 $ 6,792
Expense of premises and fixed assets 1,852 1,837
Merchant transaction expenses 3,084 3,281
Other operating expenses 4,102 3,618
- ----------------------------------------------------------------------------
Total Other Expenses $ 15,849 $ 15,528
- ----------------------------------------------------------------------------
Total other expenses increased $321 or 2.1% to $15,849 for the first nine months
ended September 30, 2005 compared with $15,528 for the same period of 2004.
Other operating expenses increased $484 or 13.4%, from increased professional
fees for ongoing banking business, costs related to the Sarbanes-Oxley Act, an
executive search and general operating expenses. Offsetting this increase were
reduced merchant transaction expenses of $197 or 6.0% relating to lower
transaction volume.
Applicable income taxes increased $513 due to higher income along with lower
tax-free income.
Loan Portfolio
Details regarding the Company's loan portfolio:
September 30, December 31,
As Of: 2005 2004
- --------------------------------------------------------------------------------
Real estate - construction and land development $ 12,848 $ 6,805
Real estate mortgages 213,363 196,149
Commercial 42,819 41,560
Credit card and related plans 3,054 2,872
Installment 26,507 25,679
Obligations of states & political subdivisions 8,054 7,111
- --------------------------------------------------------------------------------
Loans, net of unearned income 306,645 280,176
Less: Allowance for loan losses 3,704 3,600
- --------------------------------------------------------------------------------
Loans, net $ 302,941 $ 276,576
- --------------------------------------------------------------------------------
Loan Quality
The comprehensive lending policy established by the Board of Directors guides
the lending activities of the Company. Loans must meet criteria, which include
consideration of the character, capacity and capital of the borrower, collateral
provided for the loan, and prevailing economic conditions.
Regardless of credit standards, there is risk of loss inherent in every loan
portfolio. The allowance for loan losses is an amount that management believes
will be adequate to absorb possible losses on existing loans that may become
uncollectible, based on evaluations of the collectibility of the loans. The
evaluations take into consideration such factors as change in the nature and
volume of the loan portfolio, overall portfolio quality, review of specific
problem loans, industry experience, collateral value and current economic
conditions that may affect the borrower's ability to pay. Management believes
that the allowance for loan losses is adequate. While management uses available
information to recognize losses on loans, future additions to the allowance may
be necessary based on changes in economic conditions. In addition, various
regulatory agencies, as an integral part of their examination process,
periodically review the Company's allowance for loan losses. Such agencies may
require the Company to recognize additions to the allowance based on their
judgment of information available to them at the time of their examination.
The allowance for loan losses is increased by periodic charges against earnings
as a provision for loan losses, and decreased periodically by charge-offs of
loans (or parts of loans) management has determined to be uncollectible, net of
actual recoveries on loans previously charged-off.
Non-Performing Assets
Non-performing assets consist of non-accrual loans, loans past due 90 days or
more and still accruing interest and other real estate owned. The following
table sets forth information regarding non-performing assets as of the dates
indicated:
September 30, December 31, September 30,
As Of: 2005 2004 2004
- -----------------------------------------------------------------------------------------
Non-accrual loans $ 1,496 $ 1,999 $ 2,253
Loans past due 90 days or more and accruing:
Guaranteed student loans 380 253 245
Credit card loans 4 5 2
- -----------------------------------------------------------------------------------------
Total non-performing loans 1,880 2,257 2,500
Other real estate owned 122 176 44
- -----------------------------------------------------------------------------------------
Total non-performing assets $ 2,002 $ 2,433 $ 2,544
- -----------------------------------------------------------------------------------------
Loans are generally placed on a non-accrual status when principal or interest is
past due 90 days or when payment in full is not anticipated. When a loan is
placed on non-accrual status, all interest previously accrued but not collected
is charged against current income. Loans are returned to accrual status when
past due interest is collected and the collection of principal is probable.
Loans on which the accrual of interest has been discontinued or reduced amounted
to $1,496 and $2,253 at September 30, 2005 and September 30, 2004, respectively.
If interest on those loans had been accrued, such income would have been $238
and $265 for the nine months ended September 30, 2005 and September 30, 2004,
respectively. Interest income on those loans, which is recorded only when
received, amounted to $17 and $27 for September 30, 2005 and September 30, 2004,
respectively. There are no commitments to lend additional funds to individuals
whose loans are in non-accrual status.
The management process for evaluating the adequacy of the allowance for loan
losses includes reviewing each month's loan committee reports, which list all
loans that do not meet certain internally developed criteria as to collateral
adequacy, payment performance, economic conditions and overall credit risk.
These reports also address the current status and actions in process on each
listed loan. From this information, adjustments are made to the allowance for
loan losses. Such adjustments include both specific loss allocation amounts and
general provisions by loan category based on present and past collection
experience, nature and volume of the loan portfolio, overall quality, and
current economic conditions that may affect the borrower's ability to pay. As of
September 30, 2005 there are no significant loans as to which management has
serious doubt about their collectibility other than what is included above.
At September 30, 2005 and December 31, 2004, the Company did not have any loans
specifically classified as impaired.
Most of the Company's lending activity is with customers located in the
Company's geographic market area and repayment thereof is affected by economic
conditions in this market area.
Loan Loss Experience
The following tables present the Company's loan loss experience during the
periods indicated:
September 30, September 30,
Three Months Ended: 2005 2004
- ----------------------------------------------------------------------------
Balance at beginning of period $ 3,722 $ 3,500
Charge-offs:
Real estate mortgages - -
Commercial and all others - -
Credit card and related plans 13 10
Installment loans 5 5
- ----------------------------------------------------------------------------
Total charge-offs 18 15
- ----------------------------------------------------------------------------
Recoveries:
Real estate mortgages - -
Commercial and all others - -
Credit card and related plans - -
Installment loans - 1
- ----------------------------------------------------------------------------
Total recoveries - 1
- ----------------------------------------------------------------------------
Net charge-offs (recoveries) 18 14
- ----------------------------------------------------------------------------
Provision charged to operations - 114
- ----------------------------------------------------------------------------
Balance at End of Period $ 3,704 $ 3,600
- ----------------------------------------------------------------------------
Ratio of net charge-offs (recoveries)
to average loans outstanding 0.006% 0.005%
- ----------------------------------------------------------------------------
September 30, September 30,
Nine Months Ended: 2005 2004
- ----------------------------------------------------------------------------
Balance at beginning of period $ 3,600 $ 3,500
Charge-offs:
Real estate mortgages 10 -
Commercial and all others - 12
Credit card and related plans 46 23
Installment loans 12 8
- ----------------------------------------------------------------------------
Total charge-offs 68 43
- ----------------------------------------------------------------------------
Recoveries:
Real estate mortgages 47 3
Commercial and all others - -
Credit card and related plans 2 2
Installment loans 1 3
- ----------------------------------------------------------------------------
Total recoveries 50 8
- ----------------------------------------------------------------------------
Net charge-offs (recoveries) 18 35
- ----------------------------------------------------------------------------
Provision charged to operations 122 135
- ----------------------------------------------------------------------------
Balance at End of Period $ 3,704 $ 3,600
- ----------------------------------------------------------------------------
Ratio of net charge-offs (recoveries)
to average loans outstanding 0.006% 0.014%
- ----------------------------------------------------------------------------
Management believes the allowance for loan losses is considered adequate based
on its methodology. The allowance for loan losses, as a percentage of total
loans, stands at 1.21% at September 30, 2005 and 1.36% at September 30, 2004.
The allowance for loan losses is allocated as follows:
As Of: September 30, 2005 December 31, 2004 September 30, 2004
- ---------------------------------------------------------------------------------------------
Amount %* Amount %* Amount %*
- ---------------------------------------------------------------------------------------------
Real estate mortgages $ 1,100 74% $ 1,100 72% $ 1,100 73%
Commercial and all others 2,174 14% 2,070 18% 2,070 16%
Credit card and related plans 180 1% 180 1% 180 1%
Personal installment loans 250 11% 250 9% 250 10%
- ---------------------------------------------------------------------------------------------
Total $ 3,704 100% $ 3,600 100% $ 3,600 100%
- ---------------------------------------------------------------------------------------------
* Percent of loans in each category to total loans
Liquidity
The objective of liquidity management is to maintain a balance between sources
and uses of funds in such a way that the cash requirements of customers for
loans and deposit withdrawals are met in the most economical manner. Management
monitors its liquidity position continuously in relation to trends of loans and
deposits for short-term as well as long-term requirements. Liquid assets are
monitored on a daily basis to assure maximum utilization. Management also
manages its liquidity requirements by maintaining an adequate level of readily
marketable assets and access to short-term funding sources. Management does not
foresee any adverse trends in liquidity.
The Company remains in a highly liquid condition both in the short and long
term. Sources of liquidity include the Company's bond portfolio, additional
deposits, earnings, overnight loans to and from other companies (Federal funds)
and lines of credit at the Federal Reserve Bank and the Federal Home Loan Bank.
The Company is not a party to any commitments, guarantees or obligations that
could materially affect its liquidity.
The Company offers collateralized repurchase agreements that have a one day
maturity, as an alternative deposit option for its customers. The Company also
has long-term debt outstanding to the FHLB, which was used to purchase a Freddie
Mac pool of residential mortgages, as described earlier in this report. The
Company continues to have $180,363 of available borrowing capacity with the
FHLB.
Commitments and Contingent Liabilities
In the normal course of business, there are outstanding commitments and
contingent liabilities, created under prevailing terms and collateral
requirements such as commitments to extend credit, financial guarantees and
letters of credit, which are not reflected in the accompanying Financial
Statements. The Company does not anticipate any losses as a result of these
transactions. These instruments involve, to varying degrees, elements of credit
and interest rate risk in excess of the amount recognized in the Balance Sheets.
The contract or notional amounts of those instruments reflect the extent of
involvement the Company has in particular classes of financial instruments.
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract. Commitments
generally have expiration dates of one year or less or other termination clauses
and may require payment of a fee. Since many of the commitments are expected to
expire without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements.
Standby letters of credit are conditional commitments issued to guarantee the
performance of a customer to a third party. The credit risk involved in issuing
letters of credit is essentially the same as that involved in extending loan
facilities to customers.
Related Parties
The Company does not have any material transactions involving related persons or
entities, other than traditional banking transactions, which are made on the
same terms and conditions as those prevailing at the time for comparable
transactions with unrelated parties. The Bank has issued standby letters of
credit for the accounts of related parties in the amount of $6,545.
Capital Resources
A strong capital position is important to the continued profitability of the
Company and promotes depositor and investor confidence. The Company's capital
provides a basis for future growth and expansion and also provides additional
protection against unexpected losses.
Additional sources of capital would come from retained earnings from the
operations of the Company and from the sale of additional common stock.
Management has no plans to offer additional common stock at this time.
The Company's total risk-based capital ratio was 18.80% at September 30, 2005.
The Company's risk-based capital ratio is more than the 10.00% ratio that
Federal regulators use as the "well capitalized" threshold. This is the current
criteria which the FDIC uses in determining the lowest insurance rate for
deposit insurance. The Company's risk-based capital ratio is more than double
the 8.00% limit, which determines whether a company is "adequately capitalized".
Under these rules, the Company could significantly increase its assets and still
comply with these capital requirements without the necessity of increasing its
equity capital.
Sarbanes-Oxley Act of 2002
The Sarbanes-Oxley Act, enacted in July of 2002, continues to impact the
Company. A calculation of public float as of June 30, 2004 determined that the
Company was not subject to the accelerated filing deadlines of the Securities
and Exchange Commission (SEC) for 2004.
The Company has calculated its public float again as of June 30, 2005 and
determined that it is subject to the accelerated filing rules for the fiscal
year 2005. The 2005 Annual Report on Form 10-K presently is required to be filed
within 60 days of December 31, 2005. However, the SEC is considering a filing
deadline of 75 days for companies of our size. In addition, as an accelerated
filer, Section 404 of the Act will require that the 2005 Annual Report include
an internal control report that contains management's assertions regarding the
effectiveness of the Company's internal control structure and procedures over
financial reporting. The Company's auditors must also provide an opinion about
whether management's assessment of the effectiveness of its internal control
over financial reporting is fairly stated in all material respects. This has
caused management to document each type of transaction that occurs in the
Company, the risks involved in the transaction, the internal controls
established to mitigate such risks, information and communication of the results
and finally a monitoring of the controls. Affecting all of this is the control
environment within the Company. Management has spent an enormous amount of time
documenting and testing the internal control processes within the Company
utilizing outside consultants to coordinate the planning and documentation
phases of this project.
Although not subject to the accelerated filing dates until December 31, 2005,
the Company intends to file its quarterly reports this year within 40 days of
the end of each quarter and filed its 2004 Form 10K within 75 days of year-end.
PART 1. FINANCIAL INFORMATION, Item 3 --
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is the risk of loss from adverse changes in market prices and rates.
The Company's market risk arises principally from interest rate risk inherent in
its lending, deposit and borrowing activities. Management actively monitors and
manages its interest rate risk exposure. Although the Company manages other
risks, such as credit quality and liquidity risk in the normal course of
business, management considers interest rate risk to be its most significant
market risk and the risk that could potentially have the largest material effect
on the Company's financial condition and results of operations. Other types of
market risks such as foreign currency exchange risk and commodity price risk do
not arise in the normal course of community banking activities.
Achieving consistent growth in net interest income is the primary goal of the
Company's asset/liability function. The Company attempts to control the mix and
maturities of assets and liabilities to achieve consistent growth in net
interest income despite changes in market interest rates. The Company seeks to
accomplish this goal while maintaining adequate liquidity and capital. The
Company continues to evaluate its mix of assets and liabilities in response to
the changing economy.
PART 1. FINANCIAL INFORMATION, Item 4 --
CONTROLS AND PROCEDURES
Based on the evaluations by the Company's principal executive officer, Otto P.
Robinson, Jr., President and the Company's principal financial officer, Patrick
Scanlon, Controller, of the Company's Disclosure Controls and Procedures as of
September 30, 2005, they have concluded that the Company's disclosure controls
are effective, reasonably ensure that material information relating to the
Company and its consolidated subsidiaries is made known to them by others within
those entities, particularly during the period in which this report is being
prepared, and identify significant deficiencies or material weaknesses in
internal controls which could adversely affect the Company's ability to record,
process, summarize and report financial data.
Based on information available to them, they are not aware of significant
deficiencies or material weaknesses in the Company's internal control system.
Based on information available to them, they are not aware of any changes made
in internal controls or in other factors during the reporting period that could
materially affect or is reasonably likely to materially affect the Company's
internal controls over financial reporting.
Based on information available to them, they are not aware of any fraud that
involves management or other employees of the Company.
Despite these and other controls and procedures, the Company's two hundred or so
employees process over 10 million financial transactions every year. The
Company's computer systems consist of some 17 million lines of code used in the
processing of this financial information. Financial accounting rules encompass
thousands of pages of instructions and contain many confusing and "gray" areas.
From time to time honest errors in the entry, processing, or reporting of this
information are discovered or a dishonest or disloyal employee surfaces.
Fortunately, in the past any such errors or discoveries have not been material
and therefore we have never had to restate the Company's financial results. The
probability is that we won't in the future, but the possibility does exist and
the certifications marked as exhibits 31 and 32 are made subject to these
contingencies.
PART II. OTHER INFORMATION
Item 1 -- Legal Proceedings
None.
Item 2 -- Unregistered Sales of Equity Securities and Use of Proceeds
None.
Item 3 -- Defaults Upon Senior Securities
None.
Item 4 -- Submission of Matters to a Vote of Security Holders
None.
Item 5 -- Other Information
None.
Item 6 -- Exhibits
3(ii) By-Laws of Penseco Financial Services Corporation
31 Certifications required under Section 302 of the Sarbanes-Oxley
Act of 2002
32 Certifications required under Section 906 of the Sarbanes-Oxley
Act of 2002
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
PENSECO FINANCIAL SERVICES CORPORATION
By /s/ RICHARD E. GRIMM
------------------------------
Richard E. Grimm
Executive Vice-President
Dated: November 1, 2005
By /s/ PATRICK SCANLON
------------------------------
Patrick Scanlon
Controller
Dated: November 1, 2005